Thursday 24 May 2012 12.50 EDT
First published on Thursday 24 May 2012 12.50 EDT

A debate over the merits of "free" banking was raging on Thursday after top banking regulator Andrew Bailey faced criticism after appearing to call for an end to non-fee paying current accounts to prevent mis-selling of financial products.

Richard Lloyd, executive director of consumer body Which?, said it was a "myth" that banking was free. "Consumers pay over £9bn a year in fees and lost interest on their current accounts. The idea that if banks charged more, they would stop trying to mis-sell other financial products is completely unfounded," he said.

Bailey is acting head of the body that is to become the Prudential Regulation Authority, which is to be set up in the Bank of England to oversee the banking industry, following the resignation of Hector Sants at the FSA.

In a speech Bailey described himself as "like a dog with a bone" over the issue of free banking, which he said might encourage mis-selling of products because of the "unclear picture" over the price of the myraid of financial products being sold to consumers. Free banking refers to customers who remain in credit with their current accounts and who do not pay charges.

"It may require intervention in the public interest, not least because it is a way to encourage greater competition," Bailey said.

The industry has been hit by the payment protection insurance (PPI) mis-selling scandal, thought to be costing the industry £9bn after insurance was sold alongside personal loans and credit cards but rarely paid out.

Lloyd used Bailey's remarks to call for the Financial Conduct Authority, the other regulatory body being set up by the coalition to become a "watchdog that stands up for consumers and stands up to the banks", while Labour called on the Treasury to resist calls for an end free banking. Shadow financial secretary Chris Leslie said: "We need a regulator that stands up for ordinary bank account customers. The Treasury should send a strong signal that actively encouraging charges for current accounts would be unacceptable."

"Millions of ordinary bank account customers will be concerned by these comments from the government's new financial regulator, as they seem to suggest that the banks should be encouraged to charge customers for the privilege of in-credit current accounts," Leslie said.

The term "free banking" provokes debate. The Treasury select committee's report of March 2011 concluded, for instance, that "so-called free banking is not free". It described the term free-in-credit banking as a misnomer and warned that "it misleads the customer".

Mike O'Connor, chief executive of Consumer Focus, said the fact that banking "isn't really free is one of our worst kept secrets" and called for more transparency. "Most people pay indirectly either through penalties or lost interest, depending on whether they are in the red or the black," said O'Connor.

The British Bankers' Association intends to discuss Bailey's comments with him. BBA chief executive Angela Knight said: "The UK is unique in its current free banking model: customers who keep their account in credit do not expect to pay anything extra for their normal banking services. In other countries, both in Europe and elsewhere, either customers pay a fixed amount each month or there is a levy depending on the number of transactions that they undertake, plus similar costs to the UK for additional services such as unarranged overdrafts".